Crypto Analytics

Terra Collapse Could Be the End for Algorithmic Stablecoins

  • Algorithmic incentives for stablecoin pegs remain an unsolved problem, said Securitize’s head of portfolio management
  • Regulators have promised rules to protect investors, but lawmakers have yet to find a way forward

As Terraform Labs and community members scramble to rescue stablecoin TerraUSD, regulatory experts say the collapse could spell the end of algorithmic stablecoins as we know them.

“It’s a sad end to this innovative algorithmic stablecoin experiment,” said Adil Abdulali, head of portfolio management at Securitize. “Algorithmic incentives for stablecoin pegs remain an unsolved problem.”

UST tumbled dramatically this week, resolving its target strike price of $1, according to CoinGecko, and hitting a low of $0.298 earlier today. The token’s neighboring cryptocurrency, LUNA, has plunged from $86 last week to around $1.27 at the time of publication.

According to U.S. Treasury Secretary Janet Yellen, the situation is real-time evidence that lawmakers’ concerns about the stablecoin industry are valid.

“It’s quite common that we only wake up to a crisis with regulations,” said Jonathan Dharmapalan, CEO of eCurrency, which provides technology for central banks to issue and distribute central bank digital currencies, or CBDCs. “I would probably call this situation a ‘call to action’.”

For months, regulators have been promising rules to protect investors will come, but lawmakers from every government agency can’t seem to agree on a way forward.

“Stablecoins are a form of private money,” Dharmapalan said. “The problem with this is that stablecoin issuers make their own rules and no one knows if the rules are appropriate.”

Other stablecoin issuers should expect more regulatory scrutiny, Abdulali agreed, but it’s also important to consider the type of stablecoin. Reserve-backed tokens like Circle and Tether have robust reserves of safe-haven assets like cash and cash equivalents, at least according to the teams behind the coins. Algorithmic tokens like UST rely on smart contacts that incentivize to hold the price.

“Algorithmic stablecoins still need work,” said Abdulali. “None worked.”

A recent research report von Wake Forest Law Review went further, claiming that algorithmic stablecoins are inherently designed to fail. These tokens require a support level of demand for operational stability and rely on independent players with market incentives to conduct price-stabilizing arbitrage, the report states.

“None of these factors are certain, and all have proven historically weak in the context of financial crises or periods of extreme volatility,” the report said.

Other issuers should take UST’s collapse as a warning, Dharmapalan said.

“One would assume in good faith that all stablecoin issuers have actually thought about the risks and that managing those risks is an active part of their day-to-day work,” Dharmapalan said. “However, I assume that’s not really the case.”


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The post Terra Collapse Could Spell End for Algorithmic Stablecoins is not financial advice.

Source: Crypto News Austria

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